Suppose that your firm's marginal cost of producing a pencil is 5 cents and the average cost of producing a pencil is 3 cents. If your firm is interested in minimizing average total costs, what should your firm do?

Question

Quizplus · Accepted Answer

In order to minimize average total costs, the firm should decrease production. This is because average total cost is calculated by dividing total cost by the quantity produced. As the quantity produced decreases, the fixed costs are spread over a lesser number of pencils, leading to a higher average cost. However, the marginal cost of producing a pencil is still lower than the average cost, so as long as the firm produces at least one more pencil, its total costs will be reduced. Therefore, the firm should produce at the level where marginal cost equals average total cost, which is at a quantity less than the current level of production.

Suppose That Your Firm's Marginal Cost of Producing a Pencil